Accounting Standards for Private Enterprises (ASPE): 2016 year-end update

With the year-end quickly approaching, organizations are beginning to turn their attention to financial year-end activities. This guide provides a reminder of two major ASPE standards that became effective in 2016. It also provides an overview of the expected future changes to accounting standards, as well as an update on changes to the income tax rules affecting private companies.

Two major standards in effect in 20161. Section 1591, Subsidiaries: a game changer If you prepare consolidated financial statements, you will be relieved to know that Accounting Guideline AcG-15, Consolidation of Variable Interest Entities (AcG-15) has been abolished. Effective for fiscal years beginning on or after January 1, 2016, AcG-15 has been replaced with a new, more judgment-based model for determining whether you control another enterprise through contractual arrangements.

Under this model, you would consider several key factors when assessing control including:

• the purpose and design of the other enterprise;

• how decisions are made over the strategic policies of the other enterprise;

• the risks to which the other enterprise was designed to be exposed, the risks it was designed to pass onto parties involved with it, and whether you are exposed to some or all of these risks; and

• whether you have the continuing ability in a contractual arrangement to determine the strategic policies of the other enterprise without the co-operation of others.

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Accounting Standards for Private Enterprises (ASPE): 2016 year-end update

This new model applies if you have a contractual relationship with another enterprise where voting equity is not the dominant factor in determining control and the other enterprise is not under common control. In those cases, you will need to review your contractual arrangements with the other enterprise, such as supply arrangements, management contracts, lease agreements, royalty contracts and finance arrangements in order to assess whether you have control.

The assessment of control is unlikely to be ‘black and white’, and will require the exercise of professional judgment. It will be important to ensure you have considered and weighed all evidence before forming your view on whether control exists. Some of the key areas of judgment noted thus far in practice include:

• evaluating whether contractual rights provide control or are protective only in nature (for example, rights held by limited partners to ‘kick out’ the general partner in a limited partnership arrangement);

• evaluating borderline arrangements (for example, evaluating whether an enterprise which holds 49% of voting equity but also holds significant contractual rights has control); and

• evaluating whether rights held by other investors can block control.

One of the keys to successfully adopting Section 1591 will be to identify all entities that may be controlled through contractual arrangements. This means digging up your working papers of VIEs previously identified under AcG-15 and assessing whether they are controlled under the new standard, as well as looking at whether existing subsidiaries have contractual arrangements with other entities that may warrant further scrutiny. Performing your scoping early will ensure you are working with a complete population and help avoid surprises down the road.

If you are preparing non-consolidated financial statements, the impacts of Section 1591 will be limited, as you will still be able to apply the cost or equity method in accounting for subsidiaries controlled through voting equity. However, you can’t ignore contractual relationships with other enterprises - these need to be accounted for in the normal manner in accordance with the applicable Handbook sections (e.g. Leases). If you are contemplating switching to an accounting policy of consolidating your subsidiaries, you should pay close attention – as amendments, which are close to being finalized, will prevent you from applying the transitional relief if the change in accounting policy occurs after the adoption of Section 1591. The proposed amendments are discussed further below in What lies ahead in terms of accounting changes.

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Accounting Standards for Private Enterprises (ASPE): 2016 year-end update

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2. Section 3056, Interests in Joint arrangementsIf you currently have interests in joint ventures (now called joint arrangements), you may be impacted by the new standard, Section 3056, Interests in Joint Arrangements, which was also effective January 1, 2016.

Section 3056 reduces the accounting policy choices previously available to enterprises with joint control. In short, if you have joint control over a joint arrangement that consists of jointly controlled assets or jointly controlled operations, the cost and equity methods are no longer permitted - you are required to recognize your share of the assets, liabilities, revenues and expenses of the joint arrangement. In contrast, if you have an interest in a jointly controlled enterprise, you can elect to account for all such interests using the cost method, the equity method or you can elect to analyze all interests in jointly controlled enterprises. Only in those circumstances where the analysis indicates that you have rights to the individual assets and obligations for the individual liabilities of the jointly controlled enterprise, would you be able to account for your share of those assets, liabilities, revenues and expenses.

It is expected that many jointly controlled enterprises, which were formerly accounted for using proportionate consolidation, will not meet this test and will be required to be accounted for using the cost or equity method. This would lead to a collapsing of financial information down to one line on the balance sheet and income statement, which may significantly impact an enterprise’s key performance indicators and its compliance with bank covenants, which were premised on the joint venture being proportionately consolidated.

If you choose to analyze your interests in jointly controlled enterprises, you will need to invest some time. This will entail analyzing your interests in all jointly controlled enterprises and examining the relevant attributes of those arrangements (e.g., legal form; contractual arrangements; and, where relevant, other facts and circumstances, for example, where the investors purchase almost all the output from the joint arrangement) to determine the nature of your jointly controlled interest. The devil is in the details.

Experience to date indicates that the analysis of joint arrangements which involve complex legal structures (such as trusts or multi-tier partnerships) or the analysis of other facts and circumstances, will likely require more detailed consideration and analysis.

Both of the new accounting standards for subsidiaries and interests in joint arrangements are effective for 2016. If you haven’t done so already, now is the time to analyze the impact of these standards on your company’s financial statements.

If you choose to analyze your interests in jointly controlled enterprises, you will need to invest some time.

Accounting Standards for Private Enterprises (ASPE): 2016 year-end update

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What lies ahead in terms of accounting changesAlthough no major accounting standards have been issued in 2016, there are a number of significant projects underway at the Canadian Accounting Standards Board (AcSB). Depending on your circumstances, these projects could impact you. These projects include:

Clarification of Sections 1591 and 3056 transitional provisions

In September, 2016, the AcSB approved amendments to clarify that the transitional relief in Sections 1591 and 3056 applies only when an enterprise adopts those sections for the first time, and not if the entity chooses to change its accounting policies in the future. This is important for companies that currently apply the cost or equity method in accounting for their subsidiaries but are considering adopting a policy of consolidation in the future. Those companies should consider switching to consolidation in 2016, when they initially adopt Section 1591, in order to be able to take advantage of one of the simplified transition options for consolidating subsidiaries. If companies switch to consolidation after they adopt Section 1591, they will not be able to apply the transitional relief for consolidating subsidiaries. These amendments are expected to be issued in December 2016 and effective for fiscal years beginning on or after January 1, 2017, with early application permitted.

Applying the cost method to Subsidiaries and Investments

During 2016, the AcSB approved amendments to Section 1591, Subsidiaries, and Section 3051, Investments, to clarify how the cost method should be applied when an enterprise elects to use such method to account for its interests in subsidiaries and investments subject to significant influence.

The Handbook amendments, which are expected to be issued in December, 2016, include the following clarifications:

• cost would be measured at the acquisition-date fair value of the consideration transferred;

• a bargain purchase gain on the purchase of a subsidiary would not be recognized;

• a previously held interest would not be re-measured in a step acquisition; and

• acquisition costs would be expensed.

The amendments are effective prospectively to new acquisitions of subsidiaries and investments subject to significant influence undertaken after January 1, 2018, with earlier application permitted.

Redeemable preferred shares issued in a tax planning arrangement

Companies which issue redeemable preferred shares in a tax planning arrangement under specific sections of the Income Tax Act (Canada) are currently exempt from classifying these shares as liabilities, pursuant to Section 3856, Financial Instruments, paragraph 23. Based on concerns that this exception was being applied to transactions beyond estate freezes or roll-over transactions, the AcSB decided to revisit the use of this exception. During 2016, the AcSB continued its discussions as to whether it would continue to permit the exception, and the conditions under which such an exception might be permitted, with no definitive conclusions being reached. For companies which have issued such preferred shares, you are encouraged to continue to monitor progress on this project.

Agriculture

In one of its most ambitious projects to date, the AcSB is considering developing authoritative guidance for private companies in accounting for agriculture – specifically, living plants and animals and the harvested product from those assets. This project will impact entities with agricultural based operations, including raising livestock, growing crops, nurseries, vineyards and fruit orchards. In December 2015, the AcSB issued a Discussion Paper, Agriculture, which contains its key proposals for the recognition and measurement of agricultural assets, such as unharvested crops, bearer plants and animals, animals held for sale and agricultural produce. In 2016, the AcSB has held roundtable sessions with practitioners, farmers, creditors and other stakeholders across the country to obtain their feedback on the proposals. If your company undertakes agricultural activity, stay tuned for further developments in the coming months.

Accounting Standards for Private Enterprises (ASPE): 2016 year-end update

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Accounting Standards for Private Enterprises (ASPE): 2016 year-end update

On the tax frontOver the last two years, there have been a number of changes and proposed changes to the Income Tax Act that will affect private companies. Below are three topics that we believe may have the greatest impact on private enterprises.

Inter-company dividend

Recent changes to subsection 55(2) of the Income Tax Act has limited the ability of a company (private or public) to declare and pay intercorporate dividends on a tax free basis, thus the declaration of dividends may give rise to unintended results. The amendment, however, also provides an opportunity for companies to convert eligible and ineligible dividends to capital gains. Extracted funds from the corporation are then taxed at the capital gains rates, which are more favourable than dividend tax rates. These changes were effective as of April 20, 2015.

Small business deduction

The 2016 Federal Budget proposes changes to the rules that restrict access to the small business deduction and will increase the overall tax in certain corporate groups. It will also eliminate the ability for multiple partnerships and corporations in the same structure to access to the small business deduction, previously referred to as multiplying. These new rules may affect corporations with taxation years beginning after March 21, 2016. Corporate groups will have to review their structures to determine the impact of these new rules.

Eligible Capital Property (ECP)

Proposed amendments to Section 14 of the Income Tax Act are expected to dramatically change the tax treatment of Eligible Capital Property (e.g., goodwill, intangible assets). The amendments will repeal Section 14 in its entirety and will transition ECP under the current CCA rules (e.g., new CCA class with higher inclusion rate but lower depreciation rate). The changes are intended to reduce the tax compliance burden associated with the current ECP regime. The amendments will result in the elimination of a tax deferral opportunity that arises from the treatment of gains on the sale of ECP as active business income. The degree to which a company will be impacted will depend on the company, and its tax planning arrangements in place. Capital property acquired on or after January 1, 2017 may be impacted.

Looking for more information?

View our webcast where our accounting and tax specialists will discuss what these changes will mean to you, pitfalls to watch out for and other tips to consider as you prepare for your 2016 year-end financial statements.

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Accounting Standards for Private Enterprises (ASPE): 2016 year-end update

Contacts

We encourage you to reach out to a member of our team of experienced ASPE professionals who can assist your organization.

Diana De AcetisPartner, Audit416-601-6203ddeacetis@deloitte.ca

Mélanie LeducPartner, Audit514-393-5197meleduc@deloitte.ca

Gilles FleuryPartner, Tax613-751-5292gfleury@deloitte.ca

Alexia DonoghueSenior Manager, Audit416-874-3595adonoghue@deloitte.ca

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